Good day, ladies and gentlemen, and welcome to the Stamps.com first quarter 2014 financial results conference call. (Operator Instructions) I would now like to turn the call over to Jeff Carberry, VP of Finance.

Jeff Carberry

Thanks, very much. Good afternoon, everyone, and thanks for joining us. On the call today is Ken McBride, CEO; and Kyle Huebner, CFO. The agenda for today's call is as follows. We'll review the results of our first quarter 2014; then we'll discuss financial results and talk about our business outlook; but first, the Safe Harbor statement.

Safe Harbor statement under the Private Securities Litigation Reform Act of 1995, this release contains forward-looking statements, such as our expectations and financial guidance that involve risks and uncertainties. Important factors, including the company's ability to complete and ship its products, maintain desirable economics for its products, and obtain or maintain regulatory approval, which could cause actual results to differ materially from those in the forward-looking statements are detailed in filings with the Securities and Exchange Commission made from time-to-time by Stamps.com, including its Annual Report on Form 10-K for the fiscal year ended December 31, 2013, quarterly reports on Form 10-Q, and current reports on Form 8-K.

Stamps.com undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

With that, let me hand the call over to Ken.

Kenneth McBride

Thank you, Jeff. Thank you for joining us today. Today, we announced our first quarter results. During the first quarter, we achieved the following non-GAAP results: record revenue of $33.3 million; operating income of $8.4 million, with a 25.2% operating margin; net income of $8.4 million; earnings per fully diluted share of $0.50, a record high for total enterprise paid locations; and we achieved our highest level ever of paid customers at $492,000.

Overall, our results this quarter were strong, although the year-over-year comparisons were tough in just about every area of our business, as we had record results in almost every area of our business in Q1 of last year.

On the call today, we'll talk in more detail about our PC Postage metrics, our business, our financial results, and then our business outlook. So now let's begin with a more detailed discussion of the PC Postage business.

As always, we exclude all enhanced promotion channel activity from the metrics we discussed. For more detailed definition of how we calculate each of the metrics, you may refer to the quarterly investor metric spreadsheet, which is available at investor.stamps.com.

Our core PC Postage revenue, which is comprised of our small business enterprise and high volume shipping customer segments, was $31.7 million in the first quarter. Core revenue grew 5% in a very tough compare with the first quarter of last year, where core revenue was up 16%.

During the first quarter, we acquired 90,000 gross small business customers, and our cost per new small business customer acquired or CPA was $121 in the first quarter. This quarter faced a particularly tough comparison versus the first quarter of 2013, which was our best acquisition quarter ever and our acquisition this year was down incrementally versus last year, down 2%.

While we did see a modest increase in CPA compared to Q1 of last year, we are pleased with our CPA at this level and we continue to experience a very strong ROI on the customer acquisition spend, with expected lifetime value of our customers in excess of 2x of cost-to-acquire customer.

Our goal, in general, is to continue to scale our marketing spend whenever we see strong ROI, and our investment this quarter was up 11% versus last year. The increase in spend did pressure our earnings a bit this quarter, but we see that as the right trade-off in alignment with our goal of generating long-term growth in the business.

Our average monthly churn, during the first quarter was 3.0%, which was flat versus the 3.0% in the first quarter of 2013. We were pleased to see churn rates consistent with prior trends and in line with our goal of maintaining churn in a low-to-mid 3% range.

Paid customers in the first quarter was a record $492,000 that was up $25,000 sequentially versus the fourth quarter of 2013. Paid customers grew 6% year-over-year and another tough comparison to last year, when our paid customers were up 13%.

Our average subscriber revenue per paid customer or the ARPU was $21.45 in the first quarter that was down 1% versus the first quarter of 2013. Year-over-year change was in a range of single-digit fluctuations, similar to what we had seen over the past few quarters, where we had ranged from minus 2% to plus 3% over the past four quarters.

Total postage printed by all of our customers was $392 million in the first quarter. That was up 4% versus the first quarter of 2013. For this quarter, we faced a particularly tough comparison, as postage printed in the first quarter of 2013 was up 71% year-over-year.

Our first quarter results come against a background of continued challenging economic environment for small businesses, as the NFIB Index continues to fluctuate around the 93 level, which is considered a recessionary reading.

With that, now let's discuss some detailed initiatives we are working on in PC Postage. In the small business area, we plan to continue building and optimizing a customer acquisition activity, as we continue to scale our spend. We continue to see very strong return on investment that is at least twice the cost per acquisition. Thus, we plan to continue to increase our small business customer acquisition with a goal of spending at least 5% to 15% more this year.

We plan to continue utilize the marketing channels we have been using in the past, including direct mail, traditional media, online marketing and other areas. Across each of our marketing channels, we plan to continue to focus on efficiently scaling the total spend, while keeping cost per acquisition at a reasonable level.

In our enterprise area, we plan to continue scaling up our sales and marketing efforts in that area as well. Our solutions continue to have a strong customer value proposition compared to postage meters, with our dramatically lower total cost of ownership and add greater visibility and controls that are not available with postage meter.

First quarter enterprise revenue was up 15% year-over-year. The revenue growth faced a tough comparison with Q1 of '13, which was up 54% year-over-year. We were pleased with our continued progress in enterprise and feel that we're achieving a very attractive return on the investment in this area and will continue to focus on growth in this area in 2014.

In our high volume shipper area, we're continuing to ramp up our efforts. Our service continues to be a great solution for shipping with USPS for high volume shippers, such as warehouses, fulfillment houses, e-Commerce shippers, large retailers and other types of high volume shippers.

First quarter high volume shipping postage printed was up 8% year-over-year. Similarly to other metrics this quarter, Q1 represented a particularly tough comparison as high volume shipping postage printed was up 74% in the first quarter of 2013.

For 2014, we will continue to focus on scaling this business area. Continue to introduce improvements in the software and features that further improve scalability of the product to the largest high volume customers.

We'll continue to add new shopping card integrations for easier data export and import from the tools that customers like to use. And we'll continue to scale our marketing efforts and our sales efforts, using our national sales force. Also continue to scale and optimize our sales and marketing in this area.

Across all the business areas, we have and will continue to spend a lot of effort, optimizing every aspect of our customer funnel and our customer experience. We're continuing to optimize our website, our registration process, our post-registration customer interactions and other things. We also continue to launch new features in our client product that make mailing and shipping easier for our customers.

And just a word on postal reform. Congressional progress on postal reform remain slow. The USPS continues to call on congress to pass legislation that will allow them to better manage their cost, and allow them more commercial flexibility. However, there is currently no timeframe for postal reform in congress and the uncertainty continues in this area.

Our focus is on ensuring that we can do everything possible to help create value for the USPS, and we feel that we are doing this as evidenced by our continued growth in postage printed by our customers, including the growth in our high volume shipping segment.

With that, now let me turn it over to Kyle, who will provide a more detailed discussion of the financial results and our business outlook.

Kyle Huebner

Thanks, Ken. We will now review our first quarter financial results. We will discuss our financials on a non-GAAP basis, which excludes the following, stock-based compensation expense of $1 million in Q1. A reconciliation of non-GAAP to GAAP numbers is contained in the earnings release on our website.

Total revenue was $33.3 million in Q1, up 4% versus the first quarter of 2013. Growth in total revenue continues to be driven by core PC Postage revenue, which was up 5% in Q1 versus the first quarter of 2013.

Growth in core PC Postage revenue was a result of a 6% year-over-year increase in paid customers, which was partially offset by 1% year-over-year decrease in ARPU.

Non-core PC Postage revenue from the enhanced promotion channel was down 27% in Q1 versus Q1 of 2013. This decrease was expected and is a direct result of our decreased marketing spend, as we continue to reduce our investment in this area of the business.

PhotoStamps revenue was $1.0 million in Q1, up 2% versus the first quarter of 2013. PhotoStamps revenue in Q1 benefited from high volume business orders, which have become a higher percentage of PhotoStamps revenue, but are less predictable and thus can cause greater quarter-to-quarter fluctuations in our PhotoStamps revenue numbers.

PC Postage gross margin was 79.9% in Q1 versus 78.4% in the first quarter of 2013. Cost of sales included promotional expenses related to customer acquisition, which was an expense of $900,000 in Q1 compared to an expense of $1.1 million in the first quarter of 2013. The improvement in PC Postage gross margin was primarily due to cost leverage with revenue growth we have seen.

In our recorded investor metrics, our customer acquisition spend includes both promotional expenses and sales and marketing spend, as we feel they are both cost directly related to acquiring customers. As such, we feel that it is a more informative to look at the PC Postage gross margin, excluding the promotional expenses, is a better indicator of the ongoing gross profit for that business.

On that basis, PC Postage gross margin, excluding promotional expenses, was 82.6% in Q1 versus 82.0% in the first quarter of 2013. The modest improvement in PC Postage gross margin, excluding promotional expenses, was similarly primarily due to cost leverage with the revenue growth we have seen.

PhotoStamps gross margin was 19.3% in Q1 versus 19.4% in the first quarter of 2013. Similar to PhotoStamps revenue, PhotoStamps gross margins can fluctuate quarter-to-quarter based on the level of high volume business orders, which typically have a lower gross margin.

Sales and marketing spend was $11.2 million in Q1, up 10% versus the first quarter of 2013 and up from the $10.0 million spend in Q4 of 2013. The year-over-year and sequential increase in sales and marketing spend was attributable to increased marketing spend in our core PC Postage business, partially offset by decreased sales and marketing spend in our enhanced promotion and PhotoStamps businesses.

We continue to experience a very positive ROI on our marketing spend. So we we've increased our investment in this area, to continue to grow the core business.

R&D spend was $2.7 million in Q1, up 15% versus the first quarter of 2013 and comparable to the $2.6 million spend in Q4 of 2013. The increase was primarily related to increased headcount related expenses to support our expanded product offerings and technology infrastructure investments. R&D as a percentage of revenue was 8% in Q1, which was up slightly from the 7% in Q1 '13.

G&A spend was $3.7 million in Q1, up 19% versus the first quarter of 2013, but down from the $3.8 million G&A spend in the fourth quarter of 2013. The year-over-year increase was primarily related to increased headcount related expenses and infrastructure investments we made in the second half of 2013 to support the growth in the business we've experienced. G&A as a percent of revenue was 11% in Q1, which was up slightly from the 10% from the first quarter of 2013.

Non-GAAP operating income was $8.4 million in Q1, down 6% versus the first quarter of 2013. Non-GAAP operating margin was 25.2% in Q1 compared to 27.9% in the first quarter of 2013.

The decline in operating income and margin were primarily driven by the increased customers acquisition spend, as we expense the customer acquisition cost during the quarter incurred, and then earn the revenue and profits over the subsequent multiyear life of the customer. So we expect to see quarter-to-quarter fluctuation in our operating margin, depending on the level of customer acquisition spend incurred.

Non-GAAP adjusted EBITDA was $9.1 million in Q1, down 3% versus the first quarter of 2013. This metric is calculated as non-GAAP operating income plus D&A contained in operating expenses of $725,000 in Q1.

Non-GAAP net income was $8.4 million, down 8% versus the first quarter of 2013 and non-GAAP net income per fully diluted share was $0.50 in Q1, down 11% versus $0.57 per share in the first quarter of 2013.

Diluted shares used in the EPS calculation were 16.7 million in Q1, up 4% versus 16.0 million in the first quarter of 2013. We would note that our customer acquisition spend was up $2.2 million sequentially from Q4 of 2013 to Q1, which resulted in approximately $0.13 EPS negative impact versus the fourth quarter.

Capital expenditures for the business, excluding investments in our corporate headquarters, were $796,000 in Q1, which was comparable to the $773,000 in Q1 '13. We continue to invest in our technology platform to ensure an optimal customer experience.

Non-GAAP free cash flow generated by the business was $8.3 million in Q1. This metric is calculated as non-GAAP net income plus D&A contained in operating expenses, less capital expenditures related to the business.

This calculation excludes capital investments related to our corporate headquarters as well as tenant-related D&A. We ended Q1 with $106 million in cash and investments or $6.51 per ending balance sheet share.

Share repurchase. During the first quarter, we did not repurchase any shares. The company is currently authorized to repurchase up to 1.0 million shares of Stamps.com stock during the next 12 months.

NOL update. As of March 31, 2014, we had approximately $190 million in Federal NOL and $90 million in state NOLs. We estimate that as of March 31, our section 382 ownership shift was at an approximately 19% level compared with the 50% level that would trigger a potential impairment of our NOL asset. As part of our ongoing program to preserve future use of our NOL assets, we request that any shareholder contemplating owning more than 645,000 shares contact the company before doing so.

Now, turning to guidance. We expect fiscal 2014 revenue to be in a range between $125 million to $140 million. Revenue guidance is unchanged from our previous guidance. We expect 2014 GAAP EPS to be in a range between $1.80 to $2.20 per fully diluted share. GAAP numbers assume approximately $5 million of stock-based compensation expense.

Excluding the stock-based compensation expense, we expect 2014 non-GAAP EPS to be between $2.10 and $2.50 per fully diluted share. Both GAAP and non-GAAP EPS guidance are unchanged from our previous guidance. We expect growth in 2014 core PC Postage revenue to be up 5% to 10% versus 2013.

We expect enhanced promotion revenue to be down in 2014 compared with 2013, consistent with the trend we saw in Q1 as we continue to minimize our investments in this area. We expect PhotoStamps revenue will be down in 2014 compared to 2013, as we continue to minimize our investments in this area, but with quarterly fluctuations and high volume business orders as previously discussed.

We are targeting 2014 small business PC Postage customer acquisition spend to be up between 5% to 15% compared with 2013. We expect capital expenditures for the business in 2014 to be approximately $2.5 million.

So in summary, our core PC Postage business model with a recurring revenue and high gross margin is demonstrating continued strength. We continue to see a very positive ROI on our customer acquisition spend, so we continue to increase that investment to benefit the long-term growth of the business.

We have a strong balance sheet, attractive return on equity, strong free cash flow generation and a large deferred tax asset. We have demonstrated our commitment enhancing shareholder value, including returning $294 million of excess cash to shareholders via special dividends and our share repurchase program.

We believe we have a very attractive and sustainable business model and are looking forward to delivering results over the next five years.

With that, we will open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of George Sutton with Craig-Hallum.

George Sutton - Craig-Hallum

If we rewind the last quarter, I think you had some challenges on the marketing side trying to find some better efficiencies. And my sense was you were doing a fair amount of tests to try to find some new areas where you could spend money. Could you just give us an update on the progress that you're seeing there?

Kenneth McBride

We test pretty much continuously and we had seen some more challenging environment in some of our traditional media areas in the second half of last year. I think we've seen maybe perhaps some improvement in that, but not dramatic in terms of the changes. But overall, I think we're very happy with the numbers that came in this quarter in terms of the CPA, particularly given the amount of increase we were able to achieve. And we still see a terrific return on that. So I think overall, very pleased with the outcome in terms of the cost per acquisition and the overall lifetime value.

Kyle Huebner

And its historically will continue to be an ongoing process, as Ken said, optimizing testing, optimizing refining and all the different programs and channels that we use. So I don't think that's something that's significantly different than we've done historically.

George Sutton - Craig-Hallum

As I look at ARPU falling, can you help us understand -- I obviously looked to the high volume part of your businesses, something that's been giving that a lift. Can you just give us a sense of your thoughts on the ARPU side? And maybe how it translates to your high volume business?

Kyle Huebner

Yes, George, the year-over-year percent change of the down 1% is in the range that we've seen over the past four or so quarters. I think we've ranged from minus-2% to plus-3%. So quarter-to-quarter fluctuations and the year-over-year ARPU change are typical for the business and not unexpected. And I think part of that is, as shipping and enterprise are as they become bigger parts of the business, you have individual customers in those segment that can be much larger and their volumes and fluctuate as you bring new customers on or they anniversary.

We can also see factors that can cause shifts in volume between USPS and other carriers, private carriers. So again, that's kind of in the range that we've seen and it does fluctuate quarter-to-quarter as a result of the focus on high volume shipping in enterprise that we've seen. So not something that was unexpected.

George Sutton - Craig-Hallum

Last for me, obviously we saw the price change occur, I think it was about quarter ago, that gave you little bit of an advantage versus the retail Post Office pricing for the traditional mailers. Did that have any impact? It was part of your marketing program.

Kenneth McBride

We began to really kind of market that and push that also in terms of the messaging on our website and within our marketing materials. I would say, we're still fairly early on the testing and trying to understand what impact that had and sometimes it's not easy to understand exactly what result they have.

But I think generally, we feel like it's a positive message point for our customers and just another bullet we can talk about, when we talk about the value proposition of our service. And so hard to say that it had a direct positive impact, but certainly overall like a nice positive lift to the overall marketing strategy.

Operator

Our next question comes from the line of Kevin Liu with B. Riley & Company.

Kevin Liu - B. Riley & Company

In terms of the sales and marketing spend that you were able to kind of increase this quarter, did that go back into the traditional media channels on where it had slowed down before or was it other channels that you were able to find in order to allocate those dollars?

Kenneth McBride

I think generally speaking, we were able to increase our spend in most of our channels across the board, like not necessarily the same percentage in each of them, but we continue to lean heavily on direct mail, and that certainly got increase, and then also the traditional media online and other channels. So I think it probably would be characterized more on the cost of board increase.

Kevin Liu - B. Riley & Company

As you kind of look forward here, what's kind of your confidence level that you'll be able to sustain the increase in the customer acquisition spend by about this kind of 10% to 15%. Are you seeing ad rates kind of hold steady across channels where you'd like to see them or are there any signs that they might be moving in either direction, up or down?

Kyle Huebner

Kevin, our goal is to grow customer acquisition spend as much as we can, while maintaining the CPAs and kind of customer economics. So to the extent that we have opportunities to increase the spend and achieve our ROI targets, we certainly will do that for the long-term growth for the business. We did revised our target year-over-year increase in the small-business customer acquisition spend, from prior it was 5% to 10%, now we're at 5% to 15%.

So we certainly feel like if the environment continues and the others opportunities we will do so, but it's also a process of continually monitoring the environment and adjusting. So the environment can kind of change fairly quickly in either direction. So that's our goal, is to increase the spend in that range and that what we'll continuously monitor it.

Kevin Liu - B. Riley & Company

And then just lastly getting back to the ARPU question from earlier, did you guys see an increase in your transaction-based revenues? And then kind of similar to that, just wondering if the mix of revenues coming from your high volume shipping and enterprise have fluctuated much relative to prior quarter levels?

Kyle Huebner

So Kevin, the metrics that we gave, you can calculate kind of the ARPU by service fee store and insurance. And our service revenue, which is where that transaction-based revenue would be, the ARPU for service revenue was down 2%, for store it was down 2% and insurance was up 8%. So that's the data we give out, I think across all the service revenue, which is our biggest revenue component, that's where you'd see the fluctuations that can have the biggest impact, just given you the size of the service revenue relative to the other two components.

Operator

Our next question comes from the line of Tim Klasell with Northland Security.

Tim Klasell - Northland Security

Going forward if you're increasing your marketing spend and you're looking at the average lifetime value of the consumer. Are you seen that churn go down or what's giving you the confidence to increase this spend? Is there something else changing in the market that we should be aware?

Kyle Huebner

I think our existing economics are lifetime value, which incorporates churn, ARPU, gross margins is in excess of 2x the CPA, which is a function of the spend, the gross acquisition, the conversion to pay. So I think our economics are very strong, churn was consistent with historical levels.

So it's really more a question of scaling the marketing spend and making sure that we're still able to hit our target economics. So we're very confident in our customer lifetime values and the ROI relative to CPAs. So really the goal is to increase the marketing spend and maintain those ROIs.

Tim Klasell - Northland Security

And then I think the question was asked earlier about the discount on the first class postage. Have you got any feedback from the USPS on whether they feel this is successful and could we see more moves like this or is it just sort of an unknown at this point?

Kenneth McBride

Yes, I think it's probably too early to say what there -- I mean, we're just a few months into this. We started working on the discount in the year 2000. So it took us 14 years to get there. And I think our view on getting an additional discount beyond the $0.01 is, if it took us 14 years to get the first cent, it might take some time to get the second incremental discount, so I don't think we're optimistic that something in the near-term is going to change on that front.

But given that, I think we're really happy with the discount, the customers seem to be reacting positively. I think earlier I said it was hard to point it out as a factor in our overall acquisition. But I think we're pleased with the general trends on CPA and that certainly was a positive bullet that we were able to add to our marketing messages.

Operator

Our next question comes from the line of James Nie with Sidoti & Company.

James Nie - Sidoti & Company

So how should we think about the cost per new register customer for the rest of the year considering the jump that we saw in Q1 relative to last year, do you expect this metric to rise year-over-year going forward for the rest of 2014?

Kyle Huebner

Yes. So James, we don't give out specific guidance on individual customer metrics. If you look at the $121, while it was up versus last year it was in a range -- we've seen the range of CPAs between $104 and $128 during the past five years. So the $121 is still kind of right within that range, even though it was up a little bit year-over-year.

And as I said before, we do have a significant spread between the customer lifetime value and the CPA. So there is some room for that CPA to go up and still have a nice ROI. But our goal is always to optimize across all the aspects of the business, all the key metrics, which as I mentioned before, included ARPU, churn, margins as well as the acquisition-related metrics.

So as long as the overall formula of lifetime value relative to CPA is getting us a strong ROI, we'll mange the business that way and if CPAs go up a little bit, but the ROI is there, then we're comfortable with that.

James Nie - Sidoti & Company

And also how should we think about the sales and advertising spend for high volume shippers and enterprise clients. Can you talk about the trend in that compared to say a couple of years ago until now?

Kyle Huebner

If the small business base spend is typically more direct program-related spend, the enterprise is more of your lead generation and sales model and shipping is a mixture of sales integrations and program spend. So certainly that the trends in there have been -- we invest more in that area now than we did several years ago, when we were first kind of launching the business and increasing our focus.

So still there's a predominant amount of spend that comes in the form of the small business program marketing, but the level is in shipping and enterprise and acquisition spend are certainly up from a couple or few years ago.

Operator

And we have a follow-up from the line of George Sutton.

George Sutton - Craig-Hallum

This is the question coming in over the email from quite a few clients. You didn't make any share repurchases in the quarter despite the weakness in the stock. Can you just talk about your plans there?

Kyle Huebner

I mean, in any given quarter there is several factor that impact the potential share repurchase. And I think that the main thing is that we are committed to repurchasing shares over the long-term, that's been a great use of cash. If you look at while we've repurchased over the past 10 years, and if you look at that time period, we didn't necessarily repurchase in every single quarter during that time period.

And so we look at our buyback more long-term on a multiyear perspective as opposed to what happens in any individual quarter. So we do have 1 million shares authorized in place, and long-term we are committed to share repurchases, between it's the multiyear perspective as opposed to any individual quarter.

Operator

And with that I am not showing any further questions in queue. I would like to turn the call back over to speakers for any closing remarks.

Kenneth McBride

Thank you for joining us. If you have follow-up questions as always please contact us at our Investor Relations website, which is investor.stamps.com or our Investor Relation hotline which is 310-482-5830. Thanks. Bye, bye.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. And you may all disconnect.

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